Tax on ULIP withdrawal: What has changed for unit-linked insurance plans in Budget 2025?

The Union Budget 2025 has made a few changes to tax policies, clarifying the taxation of Unit Linked Insurance Plans (ULIPs). Finance Minister Nirmala Sitharaman, in her Budget speech on Saturday, announced that from April 1, 2026, ULIPs with annual premiums exceeding ₹2.5 lakh will no longer be exempt from tax under Section 10(10D) of the Income Tax Act, 1961. Instead, these policies will be taxed under capital gains. The long-term capital gains (LTCG) from policies held for more than a year will be taxed at 12.5%.

Tax treatment of ULIP proceeds

As per the Budget 2025 announcement, redemption proceeds from ULIPs that exceed the premium threshold will now be classified as capital gains. They will be taxed under Section 112A of the Income Tax Act. If the policy is held for over 12 months, the redemption will be treated as a long-term capital asset, attracting a 12.5% tax.

The new framework ensures consistency by treating ULIPs in the same manner as equity mutual funds, aligning their taxation with other capital market instruments. This is expected to impact investors who earlier relied on ULIPs for tax-efficient wealth accumulation, as the tax treatment of their profits will now be more straightforward and predictable.

Rationale behind the changes

The changes introduced in the Union Budget 2025 build on the Finance Act 2021, which had already restricted tax exemptions for ULIPs with premiums exceeding ₹2.5 lakh. The aim was to prevent high-value investment products from being misused as tax-saving vehicles under the guise of life insurance policies.

"This move is expected to streamline the tax treatment of ULIPs and other insurance policies and help taxpayers better understand how to plan their finances and tax obligations around life insurance investments. By offering more clarity regarding the tax treatment of life insurance policy proceeds, including the introduction of capital gains taxation for ULIPs in specific cases, the government aims to assist taxpayers in making informed decisions about their financial planning," says CA Dr Suresh Surana.

Before these amendments, there was inconsistency in the taxation of ULIPs, with some treated as capital gains and others as ‘income from other sources’, leading to confusion among investors.

The new changes resolve this inconsistency by explicitly defining the tax treatment of ULIPs, ensuring that all non-exempt policies are categorised as capital assets and taxed accordingly.

What this means for investors

The shift to taxing ULIP proceeds as capital gains means that policyholders with high-premium ULIPs must now prepare for tax on their redemption proceeds under the capital gains framework. This applies specifically to policies that do not qualify for exemptions under Section 10(10D), which allows an exemption for proceeds of a life insurance policy where the premium does not exceed 10% of the sum assured.

Investors will also need to consider the distinction between short-term and long-term capital gains when making decisions about their ULIPs. The tax rate on long-term capital gains for equity investments remains lower than that on regular income, which could benefit long-term investors in ULIPs.

With this amendment, the taxation framework for ULIPs has been further refined, ensuring a more uniform approach across different types of investment products.

ULIPs are a category of insurance plans that combine life insurance with investment. Such plans offer dual benefits of insurance and market-linked returns. A portion of the investment is used for insurance cover, while the remaining part is invested in equity and debt instruments.